Adding insult to injury: how In re Venture Mortgage Fund exposes the inequitable results of New York's usury remedies.

• Author: Berger, Shimon A.

INTRODUCTION

For centuries, usury laws protected needy and desperate debtors from lenders' outrageous demands. (1) The protection of the needy and desperate, of the uninformed and unsuspecting, has been the upstanding principle behind these laws. (2) Usury laws are one of the earliest forms of consumer protection law, (3) having been in place over a millennia and within a wide variety of cultures in order to protect "the needy from the greedy." (4) This ideal was seemingly not in dispute in 1787 when Jeremy Bentham posed the classic freedom of contract objection to usury regulation. (5) While he postulated that, "no person of `sound mind' who is `acting freely' should be hindered from striking a loan bargain on terms she finds acceptable," (6) usury proponents disagreed, claiming that Bentham's ideal contradicts the moral policies that require usury regulation. (7) They have decried Bentham's depiction of loan bargaining as "rosy-eyed and idealistic." (8) To add to the debate, outrageous episodes of lender abuse in the 1990s have bolstered a strong consumer protection movement. (9) Some initiatives have focused on the inadequacies of current systems in regulating certain lending activities, (10) such as the new loan sharks who operate "auto-title pawns" (or "title loans"), (11) and "payday lenders." (12) Others have focused on modern predatory lending practices, which threaten desperate and needy borrowers. (13)

What has since emerged from the usury debate amounts to a distinction between borrowing by unsophisticated or desperate parties, and borrowing in a commercial context, which presumes a level of sophistication and equal footing. (14) Usury regulations in most states "treat corporate or business borrowers differently than consumer borrowers." (15) This manifests itself in allowing higher interest rate ceilings for corporate borrowers, exempting corporate loans from usury limits altogether, and even extending the "corporate exemption" to business loans generally. (16) Yet, even in a commercial context, small businesses may have less familiarity with commercial transactions and might suffer as much as unsophisticated consumer borrowers. (17) On the other hand, usury opponents, realizing the consumer justifications for strong usury regimes, argue that legislators should resist reaching for the blunt instrument of usury to restore contractual order in the marketplace, (18) arguing for a cost justification standard of unconscionability. (19)

However, most of the usury debate today focuses on the usury laws themselves. Should interest limits be adopted, or should states turn to the unconscionability standard as their model to combat predatory lending? (20) There are also advocates and consumer protection groups that promote new legislation addressing loop-holes that allow "fringe banking predatory lending" (21) to flourish. (22) The current debate, however, has not adequately focused on the various usury remedies and their impact on equitable policy concerns. Usury remedies are notoriously nonuniform, (23) but usury penalties have historically been more severe than they are now. (24) The most common remedy for usury violations is the disallowance of the entire interest charged. (25) A few states void only the interest that exceeds the usury limit, (26) but most usury regimes levy some additional sanction, such as the forfeiture of all the interest, as a deterrent. (27) However, some states still impose severe punitive civil sanctions, denying the recovery of not only the interest but the loan principal as well. (28) Additionally, only a few states provide for criminal penalties for usury violations. (29) How these various approaches to usury remedies impact the general usury debate has not been adequately explored.

This Note evaluates New York's usury remedy regime, which is among the most severe in the country. This Note focuses exclusively on the ramifications of New York's severe usury remedy regime, and how it leads to inequitable results which are contrary to the underlying purpose of the usury laws. These inequitable results are illustrated by the Southern District of New York Bankruptcy Court's decision in In re Venture Mortgage Fund, L.P. (30) and subsequent decisions which reflect a basic flaw in New York's usury laws. Part I of this Note discusses the history of New York's usury laws, focusing on their origins and public policy concerns that have been applied throughout the ages. Part II analyzes In re Venture Mortgage Fund and subsequent decisions, including a discussion of the background of the failed ponzi scheme that led to the ongoing bankruptcy proceedings in the case. Part III analyzes New York's usury remedies as compared to other remedy regimes, and argues that the New York legislature should adopt remedies that more adequately reflect the equitable purpose of the usury laws. This Note concludes that although the forfeiture of principal is a useful deterrent, the adoption of a discretionary standard will provide equitable results and at the same time keep the deterrent factor in place.

1. HISTORY OF NEW YORK'S USURY LAWS

   1. Origins of American Usury Law--Usury in Medieval Europe and England

      The history of credit, and thus usury, dates back to ancient times. According to some historians, credit long predates industry, banking, coinage, and probably even money. (31) Along with the discovery of credit came the concept of charging some form of compensation for the extension of the credit. (32) Ever since man discovered credit and later, the monetary system, societies have been developing ways to regulate credit and the amount of compensation charged for credit. (33) The first recorded usury laws date back to around 1800 B.C.E. in the Code of Hammurabi, which contained statutory limitations on interest rates. (34) The Romans placed an interest cap limit at eight and one-third percent. (35) However, these limitations on interest rates usually had little practical effect; when market rates were higher than the legal rate, the legal rate was usually simply ignored. (36)

      The Bible and English statutory and common law were the strongest influences on the regulation of usury and abusive interest rates in the United States. (37) In medieval Europe, usury laws were under the influence of the Catholic Church ("the Church"), which prohibited lending for any profit. Thus, no amount or rate of interest on a loan was allowed, and the Church repeatedly condemned the assessment of usury. (38) The Church based its condemnation on the Bible, which specifically prohibited interest taking in three separate verses. (39) The Church shared the belief of many other societies throughout history that the taking of interest was unjust, which stemmed from a desire to prevent the exploitation of the needy. (40) The Church used this rationale to target the medieval equivalent of the "loan shark," because a loan often represented an unequal bargaining position by the lender, leading to possible exploitation of the borrower. (41) Moreover, the Church felt that interest would enable the rich to get richer and the poor to get poorer. (42) As in the rest of medieval Europe, the Church was also the chief authority on the regulation of usury in medieval England, in both its prohibition and its enforcement. (43) The penalties for practicing usury, as administered by the Catholic authorities, usually included the forfeiture of the entire loan principal and the return of any loan principal or interest payments already collected. (44) The religious penalties typically included a censure from the Church and excommunication. (45) Furthermore, the lender was denied a Christian burial until his estate paid back any usury or principal. (46)

      Early English secular usury statutes also prohibited the taking of any interest. The earliest usury statutes in England date back to the laws of Alfred the Great and later the laws of Edward the Confessor and William the Conqueror. (47) These early statutes served mainly to strengthen the Church's usury prohibition by setting an absolute ban on usury, prohibiting the charging of any interest, and exacting civil penalties in addition to those already administered by the Church. (48) The usury statute of Edward III in 1341 (49) gave the Church the authority to administer penalties during the life of the usurer, while the crown was given control over usury enforcement after the usurer's death. This included having the usurer's goods forfeited to the king, (50) and his lands returned to the lord of the fee. (51) England further enacted usury statutes in 1487 (52) and 1494, (53) during the reign of Henry VII, which greatly enhanced the crown's control over usury regulation and enforcement. These statutes called for usury cases to be brought in the courts of the crown, common law courts, and local tribunals, instead of solely in the ecclesiastical courts. (54) Thus, for much of the early period of English legal history, usury laws adhered to Canon Law (55) and Church doctrine, totally outlawing the charging of interest.

      In early sixteenth century Europe, it was realized that the complete prohibition of lending for profit impeded economic development, (56) and as a result, the religious opposition shifted from an absolute usury prohibition to a less stringent standard of a "moral opposition to abusive interest." (57) With growing trade and commerce, the tension between the need for economic development and the desire to insulate society from excessive, and sometimes oppressive, debt became more difficult to balance. (58) This was especially true for the merchants, traders, and industrialists who needed extra capital to expand their commercial enterprises. (59) The continuing power of the Church made it difficult to simply ignore the usury restrictions when they became inconvenient, (60) and so lenders and borrowers began to devise creative ways of evading usury restrictions, (61) These included...